The Macroeconomic Effects of Inflation Targeting/Commentary
Levin, Andrew T., Natalucci, Fabio M., Piger, Jeremy M., Uhlig, Harald, Review - Federal Reserve Bank of St. Louis
Andrew T. Levin, Fabio M. Natalucci, and Jeremy M. Piger
Over the past 15 years, explicit inflation targeting (IT) has been adopted by an increasing number of central banks, and a substantial body of literature has emphasized the advantages of this approach as a framework for monetary policy.1 Nevertheless, empirical analysis has yielded little evidence of any macroeconomic effects of IT. For example, the landmark study of Bernanke, Laubach, Mishkin, and Posen (1999) concluded that the first few countries to adopt IT did not experience any short-run gains in lower output costs of disinflation. Most recently, Ball and Sheridan (forthcoming) considered a wide range of macroeconomic indicators for Organisation for Economic Cooperation and Development (OECD) economies and found no statistically significant differences between the IT and non-IT countries.
In this paper, we evaluate the extent to which IT exerts a measurable influence on expectations formation and inflation dynamics. For the industrialized economies, we address this question by comparing time-series data since 1994 for five IT countries (Australia, Canada, New Zealand, Sweden, and the United Kingdom) with that of seven non-IT countries (the United States, Japan, Denmark, and four of the five largest euro area members-namely, France, Germany, Italy, and the Netherlands).2 For these economies, we analyze the behavior of medium- and long-term inflation expectations using Consensus Economics Inc. semiannual surveys of market forecasters, and we employ the methods of Stock (1991) and Hansen (1999) to obtain median-unbiased measures of persistence for total and core consumer price inflation (CPI). Finally, since the experience with IT in the emerging market economies (EMEs) is mainly limited to the past few years, our analysis of these economies follows an event-study approach similar to that of Bernanke et al. (1999).
For the industrialized economies, our evidence indicates that IT has played a significant role in anchoring long-run inflation expectations. For the United States and the euro area, private-sector inflation forecasts (at horizons up to ten years) exhibit a highly significant correlation with a three-year moving average of lagged inflation.3 In contrast, at the longest horizons this correlation is largely absent for the five IT countries, indicating that these countries' central banks have been quite successful in delinking expectations from realized inflation.4
We also find that actual inflation exhibits markedly lower persistence in IT countries.5 For example, even with only a decade of quarterly data, we can clearly reject the null hypothesis of a unit root in core CPI inflation for Canada, New Zealand, Sweden, and the United Kingdom. Inflation persistence is estimated to be quite low in these countries, with the 90 percent confidence interval for the largest autoregressive root excluding 0.7 in all cases. By contrast, the unit-root null hypothesis cannot be rejected for the United States, the euro area, or Japan.6
For the EMEs, the initial experience with IT appears to be largely consistent with that observed by Bernanke et al. (1999) for the industrialized countries.7 In particular, our event-study approach confirms that the adoption of IT is not associated with an instantaneous fall in private-sector inflation forecasts, especially at longer horizons. Since measures of potential output and the natural unemployment rate are notoriously difficult to construct for EMES, we have not attempted to compute sacrifice ratios for these episodes; however, informal assessment suggests that the adoption of IT was not associated with a marked reduction in the output costs of disinflation.
It should be noted that the absence of instantaneous gains from IT is not necessarily inconsistent with substantial macroeconomic effects over a period of a decade or more. If an economy has already been experiencing low and stable inflation for an extended period, then the adoption of a formal IT regime might not have any immediate benefitthe delinking of expectations from realized inflation would only become visible at some later date when the economy was hit by a substantial shock. …